WSJ Reporter’s Outlook on China’s Economy in 2019
When Dinny McMahon was growing up in Australia, his father was troubled by a trend he noticed during international engineering projects. Most Australians could only speak one language, a disadvantage in the global market. Dinny’s father decided that his son needed to learn Mandarin Chinese. The choice paid off. Dinny spent several years in China as a correspondent for the Wall Street Journal, covering the Chinese Economy. He’s gone on to work at think tanks and write a book, China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle.
Dinny joined me for a podcast conversation to discuss his take on China’s Economy in 2019. This article covers the main ideas of our episode, including China’s image as a global power, how to invest around the Chinese economy, and tips for outsiders who want to understand China. To listen to my full conversation with Dinny, check out the YouTube video embedded below.
Our conversation began and ended with discussion of the Chinese language. Dinny is fluent in Mandarin and credits his language skills for getting his mind around the Chinese economy. He explained that you can’t trust the numbers in China. Often, they are invented or fail to tell the whole story. Numbers may not represent objective truths, but show the outcomes that political leaders want to achieve. For Dinny to get down to the truth, he needed to speak with real human beings. He layered his analysis over people’s stories to find the narrative behind the figures. When he had real conversations in Mandarin, then he could stop taking things at face value.
the, “Complete black box,” of China’s economy
Speaking with people in Ghost Cities gave Dinny a special advantage for understanding what he called the, “Complete black box,” of China’s economy. He explained that a Ghost City is not like an American Ghost Town, but the reverse. An American Ghost Town is a place in demand because of valuable resources. It rapidly fills with people and the infrastructure goes up fast. When the resources dry up, the Ghost Town empties out. A Ghost City is more if you build it they will come. The government wants to see an area prosper, builds an enormous city, then hopes that people fill it. The population is seeded by bureaucrats who work for the Ghost City. The government can close a nearby school and force children to attend school in the Ghost City instead. Sometimes, the plan works out because industry is attracted to the city and brings a population of employees, but not always.
The Chinese non-performing loan rate of 1.89%, “Defies credulity,”
When Ghost Cities and other massive projects fail, they exemplify the main topic of Dinny’s book, risky debt-led investments. China is in the most aggressive expansion of debt in modern history and there is no guarantee that it can last forever. It may already be a problem, but the numbers aren’t clear. The Chinese non-performing loan rate of 1.89%, “Defies credulity,” according to Dinny.
Is China’s debt serving as a runway that they can take off from? We discussed two deeper questions that may provide answers.
First, how does China deal with debt? Non-performing loans can’t be understood because they are hidden in the shadow banking system. Until these are seen, it is hard to fix them.
Second, what does China do to keep growing? Debt-led investment is powerful, but not sustainable. China will need a new growth model with less debt. Dinny proposes that the Chinese will try to move up the value chain to high tech industries, such as robotics and semiconductors.
Statistically, it is unlikely that China will ever become a rich nation.
The change will come from the top-down, because the top is driving the growth. The political incentives for growth have evolved, but continue to influence the entire country. A few years ago, the goal was job creation. Now, it’s about achieving the China Dream of world power and avoiding the “middle income trap.” In 2008, the World Bank discovered that very few countries achieve first-world economic standards, despite promising starts. Statistically, it is unlikely that China will ever become a rich nation. This is the middle income trap.
The elite minority of a nation of more than 1 billion people is a big group that is easily mistaken for the whole.
For an outsider, like myself, it was strange to learn about China’s tenuous position in the world. I already see China as a rich and powerful country, but Dinny explained that this is a facade. When I travel to Rome and see Chinese tourists sporting Versace clothes, they do not represent the whole Chinese population. Traveling Chinese people with passports and disposable income are the elite minority. The elite minority of a nation of more than 1 billion people is a big group that is easily mistaken for the whole. Add images of hyper-modern cities and the Beijing 2008 Olympics and China has an excellent image. Dinny explained to me that the image is not reality for many poor Chinese people living in tents and windowless, underground apartments.
If the masses are in poverty, they still have faith in their government. Faith keeps the whole debt-led investment industry running. The Chinese trust that their government will not allow loans to fail and lending continues. This debt is paradoxical — the strength and Achilles’ heel of the Chinese economy. There is pressure to continue and faith that the government will serve as a backstop, but lenders are bound by rules that limit them. So, they create new systems outside of the rules, such as Shadow Banking. There is a Chinese phrase for this, “From above there is policy, from below there are countermeasures.”
So, how can investors take advantage of Chinese growth without being vulnerable to instability? Dinny suggests a nuanced approach. Segment your choices for industries that the government supports (e.g. Huawei). The question is no longer, “Is China up or down?” The investment scene requires more understanding.
To understand China, learn the language, like Dinny McMahon. To better understand Dinny’s ideas about the Chinese economy, click here to listen to our full interview.